Dusk of dominance

A recent IMF document claims that there’s ’stealth erosion' in global US dollar reserves, but there's no dominant replacement yet. While the dollar is still by far the most dominant currency in the foreign exchange reserves of the world's central banks, its share in these reserves — after exchange-rate and interest-rate adjustments — declined from over 70 per cent in 2000 to about 55 per cent in the last quarter of 2023. An analysis of global foreign exchange reserve (FX) by the IMF shows that the most notable development during 2022-23 has been an increase of gold purchases by central banks. The share of gold in total FX reserves of China has increased from less than 2 per cent in 2015 to 4.3 per cent in 2023. During the same period, the value of China’s holdings of US Treasury and Agency bonds relative to FX reserves has declined from 44 per cent to about 30 per cent.

World War I: the end of Gold Standard and birth of the US Dollar

The US dollar completes the hundred and tenth year of its birth in 2024. During this long period the US dollar has dominated the global economy and helped to establish USA’s hegemony as a global economic superpower. It may be recalled that the Federal Reserve Bank was created in 1913 to provide stability against a currency system based on bank notes issued by individual banks in the USA. By then, the US had already become the world’s largest economy, but Britain was still the centre of commerce. Great Britain, and most of the developed countries, used the gold standard to benchmark their currency. But with the advent of World War I in 1914, many countries abandoned the gold standard as their reserves dwindled and used paper money to cover military expenses. This often led to a devaluation of their currencies. It was during this time that the first US Dollar was printed in 1914 by the Federal Reserve Bank.

Quite expectedly, when WW1 broke out in 1914, far away from the US mainland, the prevailing American public opinion was to remain neutral. The 28th US president Woodrow Wilson also did not want to join the war. But in early April 1917, Wilson asked the Congress for “a war to end all wars” that would “make the world safe for democracy.” Thus, on April 6, 1917, the Congress voted to declare war on Germany, then optimistically called the “Great War.”

The United States did not want to miss an opportunity to establish its supremacy over the war withered Europe, Japan and Ottomans. But American public opinion, as before, was not in favour of joining the war. To influence public opinion to support the US in World War I, a Committee on Public Information (1917–1919), also known as the CPI or the Creel Committee, was created. It was an independent agency of the government of the United States under the Wilson administration. As chairman of the Committee on Public Information, George Creel—a journalist—became the mastermind behind the US government’s propaganda campaign in the Great War. For two years, he rallied the American public to the cause of war and sold the globe a vision of America and President Wilson’s plans for a world order. CPI inducted many strategists and public opinion experts in its team. Edward Bernays, the “father of public relations” and the author of numerous books like ‘Engineering of Consent’ (1947), ‘Propaganda’ (1928), etc. chaired the CPI Export Service.

To successfully influence public opinion in favour of the war, the CPI produced films, commissioned colourful posters, published books and pamphlets, took out advertisements in newspapers, and recruited everyday Americans to speak to their communities and “sell the war.” A barrage of patriotic messaging served to justify American participation in the war and convinced many who, prior to 1917 had favoured peace, to support the war effort. Images like James Montgomery Flagg’s “Uncle Sam Wants YOU,” were created to encourage men to volunteer for military service, promote food conservation, illustrate alleged German atrocities and sell war bonds. Over the course of the war, the United States produced more war posters than all other belligerent nations combined. From 1917 to 1918, the Creel’s Committee on Public Information successfully unified the American people while minimising the influence of those who remained committed to neutrality.

Thus, in addition to the birth of the US Dollar, WW1 also gave birth to a US military establishment. The era of US dominance began.

After WW1, it was impossible to reconstitute the gold standard, mostly because the US owned almost the entire world’s gold! Nonetheless Britain remained on the gold standard to maintain its position as the world’s leading currency. As the war went on, Britain was forced to borrow money from the US. In 1931, Britain finally had to abandon their strict adherence to the gold standard amid the Great Depression. This allowed the Dollar to replace the Pound as the world’s leading reserve currency.

Emergence of Gold Equivalent Standard

Unlike the superpowers of the 19th century, namely the Ottomans and the British, which had subjugated vast geographical regions under their direct control, the USA followed a different approach in the 20th century to retain its global supremacy. The difference between the American and the previous empires was that the former usually preferred to work through local compradors: local rulers who were on their side. The creation of the Japanese Liberal Democratic Party after the Second World War, to retain their control on Japan, is a case in point. In addition to this political strategy, the other most important factor which has contributed immensely to maintaining America’s economic supremacy was the unprecedented strength of its national currency, the US dollar.

The fall of the gold standard in 1914 and subsequent chaos, between two World Wars, in the international financial system, resulted in a new system (the Bretton Woods System) in 1944. Under the new system, all members of the newly set up International Monetary Fund (IMF) were to fix the par value of their currency either in terms of gold or in terms of US dollar. The par value of the US dollar in turn was fixed at USD 35 per ounce of gold. For the purpose of such conversion, adequate gold reserves had to be maintained by the US government. Thus the dollar, the national currency of the USA, was made equivalent to gold which, for centuries, had been used as the most acceptable currency across the globe. This unique status of the dollar had encouraged the US Fed to act as the de-facto Central Bank of the world.

Prof Robert Triffin cautioned the world about the inherent limitations of the Gold Equivalent Standard, as early as 1960, and predicted its breakdown. According to him, it was necessary for the US to run a balance of payment (BoP) deficit to supply the world with the additional dollar reserves needed for increased international trade. As the volume of dollar reserves in other countries would grow without a simultaneous increase in US gold reserves, its ability to honour its commitment of converting dollar into gold would decrease, resulting in the breakdown of the system.

Triffin’s prediction proved correct within a decade. The long Vietnam War during the 1960s had forced the US government to print dollars to meet its war expenditure at a disproportionately higher value compared to the official gold reserve the government had at its disposal. As the US government was not in a position to honour its commitment of paying USD 35 against every ounce of gold, on August 15, 1971, they allowed their currency to float. As expected, the value of the US dollar started to erode. The USA government tried to salvage the crisis by entering into an agreement (Smithsonian agreement) with 10 major members of the IMF. As part of this agreement, the dollar was devalued by raising the price of gold from USD 35 to USD 38 per ounce. In February 1973, it was further devalued to USD 41.22 per ounce, and finally in mid-March 1973, when major industrial countries had decided to float their currency, the Bretton Woods system of Gold Equivalent Standard was finally abandoned.

Emergence of ‘Oil standard’

Economic historians claim that the oil shock of 1971 had aggravated the US BoP crisis that ultimately led to the breakdown of the global financial system in 1973. Interestingly, the USA had turned the Arab anger and the associated oil shock of the 1970s into their advantage. It is alleged that the Middle-east crisis was “engineered‟ to establish a new “oil standard” replacing the existing “gold equivalent standard‟.

On October 6 1973, Egypt and Syria had attacked Israel. And on October 19, the US President declared an aid package of USD 2.2 billion to Israel, knowing fully well that it would force the Arabs into taking drastic actions. As anticipated, Arab oil producers led by Saudi Arabia, imposed a total embargo on oil shipments to the United States, and by January 1974, the price of Saudi crude leaped to a new record. The USA formulated a strategy to (a) ensure that OPEC would funnel the billions of additional dollars earned on increased oil price back to US shores; and (b) establish a new ‘oil standard’ to strengthen the weakening dollar. The USA and Saudi Arabia established a Joint Commission for economic cooperation in June 1974, which aimed to help Saudi Arabia spend its sudden influx of dollars on American products. Then a second Commission was established to help Saudi Arabia’s military needs.

In return to US promise of keeping the Saudi royal family in power, the latter had agreed to (i) invest a large portion of their petro-dollar in US government securities; (ii) allow the US government to utilise trillions of dollars, payable as interest on these investments, to hire US corporations to westernise Saudi Arabia; and (iii) maintain the price of crude within limits acceptable to the corporations. The second objective was achieved by earning a commitment from the Saudis to trade oil exclusively in US dollars. Thus dollar sovereignty was re-established.

On June 8, 1974, the New York Times reported on its front page: “Secretary of State Kissinger and Prince Fahd Ibn Abdel Aziz, Second Deputy Premier of Saudi Arabia and a half-brother of King Faisal, signed the six-page agreement at Blair House across the street from the White House this morning. The deal was about economic cooperation and supplying Saudi Arabia’s military needs”. The text of the pact has never been made public but it became clear subsequently that with the agreement, President Richard Nixon had found a way to arrest the sharp decline of the US currency.

This arrangement benefited both the US and oil-exporting countries, as it created a stable demand for dollars and provided a reliable investment vehicle for oil revenues. As of 2023, approximately 80 per cent of the world's oil transactions are priced in US dollars. In addition to stabilising the dollar value, the increased demand for US Treasury securities from oil-exporting countries helps to keep the US interest rates lower than they might otherwise be, benefiting the US government and consumers.

End of the dollar raj

Recently, a short opinion piece on the Nasdaq website noted that the 50-year-old petrodollar agreement between the United States and Saudi Arabia expired on Jun 9, 2024. However, the US mainstream news media have chosen to remain silent about the event.

It is believed that the crucial decision to not renew the contract enables Saudi Arabia to sell oil and other goods in multiple currencies, including the Chinese RMB, Euros, Yen, and GBP, instead of exclusively in US dollars. Additionally, the potential use of digital currencies like Bitcoin may also be considered.

Lately, Saudi Arabia has announced its involvement in Project mBridge, a project which explores a multi-central bank digital currency (CBDC) platform shared among participating central banks and commercial banks. It is built on distributed ledger technology (DLT) to enable instant cross-border payments settlements, and foreign-exchange transactions.

Project mBridge is the result of extensive collaboration starting in 2021 between the BIS Innovation Hub, the Bank of Thailand, the Central Bank of the United Arab Emirates, the Digital Currency Institute of the People's Bank of China and the Hong Kong Monetary Authority. In 2022, a pilot with real-value transactions was conducted. Since then, the mBridge project team has been exploring whether the prototype platform could evolve to become a Minimum Viable Product (MVP) – a stage now reached. It is reported that as it enters the MVP stage, Project mBridge is now inviting private-sector firms to propose new solutions and use cases that could help develop the platform and showcase all its potential.

The project has more than 26 observing members, including the South African Reserve Bank. The better known observing members of mBridge are those of the Bank of Israel, Bank of Namibia, Bank of France, Central Bank of Bahrain, Central Bank of Egypt, Central Bank of Jordan, European Central Bank, the International Monetary Fund, the Federal Reserve Bank of New York, the Reserve Bank of Australia, and the World Bank.

Days before the G7 Summit in Italy, held last week, BRICS foreign ministers had met in the Russian city of Nizhny Novgorod. Ways for pushing forward de-dollarisation – reduction of dependence on the US dollar for trade – were discussed. It is believed that the main reason for Saudi Arabia and other countries moving towards trade in local currencies is the stringent sanctions imposed by the US on Russia and Iran. As a result, there has been a significant rise in non-dollar trade in commodities in recent years (India itself has been pushing for commodity trade in local currencies).

Observation

If the political economic history of the world is analysed, it can be observed that during the last two centuries, three major power centres—the Ottomans, the British and the Americans—have dominated the global economy to a large extent. The transition of political power from the dominant to the emerging centres was always marked with some major global events like the First World War and the Great Depression of the 1930s followed by the Second World War. History reminds us that the 1st and 2nd World War triggered the fall of two large empires—the Ottomans and the British.

The colossal global debt crisis, if not properly managed, can cause another great recession in near future. In addition to this the prolonged Russia-Ukraine war and North Korean leader Kim Jong Un’s promise of “full support and solidarity” for Russia’s war in Ukraine, as President Vladimir Putin visited Pyongyang this week, has aggravated the possibility of a third World War. Will WWIII prompt the end of the American empire?

For over a century the USA has dominated the global economy and politics with the help of its national currency dollar. Rapid shift in global geopolitics indicates the emergence of a new world order where the century-long hegemony of the US dollar will be replaced by a truly democratic multi-currency global financial system.

Views expressed are personal